War fears and market jitters

The oil price approached $30 a barrel over the past week on fears of an American invasion of Iraq. The real danger the war poses may be of an interruption in the supply of oil from Saudi Arabia, which sits on a quarter of the world’s reserves


THE CURRENT gyrations in the oil price are a reminder of one possible side-effect of any American war against Iraq. With fears mounting that the American economy may relapse into a “double-dip” recession, the last thing it needs is a higher oil price. But, just as the price of West Texas Intermediate, the benchmark for American crude oil, was subsiding after a surge, a speech by Dick Cheney, the American vice-president, a week ago, calling for action against Iraq, sent the price soaring again. Matters were not helped by a statement from Venezuela that the Latin American oil producer would oppose any relaxation of supply quotas at this month's meeting of the OPEC oil producers cartel in Japan. The combination of talk about a possible war against Iraq and continuing supply concerns is likely to keep the oil market jittery in the short term.

Iraq sits on the world's second-biggest oil reserves, well over 100 billion barrels—or 100 years of production at current rates. So there are understandable fears about the interruption of supplies if America launches a war to depose Saddam Hussein, the Iraqi dictator. However, those fears may be overstated. This is not because the Iraqis are—somewhat optimistically—claiming that the war would not interrupt supply. (The Iraqi planning minister, Hassan al-Khattab, insisted on August 29th that the country would continue to export even if attacked.) It is rather because Iraq's production and exports are already a fraction of their potential. The effects of United Nations sanctions and Mr Hussein's own disastrous economic policies have already sharply reduced Iraq's oil exports. On September 2nd, Iraq said that American and British “unfair” pricing policies had reduced exports from 1.7m barrels per day (bpd) last year to just 800,000 bpd last month.

Of more concern is what may happen to the oil fields of Kuwait and Saudi Arabia. Iraq suffers UN sanctions as punishment for the invasion of Kuwait in 1990 and because of fears that it retains the sort of weapons of mass destruction that it has used in the past. Kuwaiti and Saudi officials are both, in contrast to their countries' stances during the 1991 Gulf war, distancing themselves from American opposition to Mr Hussein. In the volatile atmosphere of the Middle East, with widespread resentment of repressive regimes across the region, disruption of supplies in neighbouring countries cannot be ruled out.

There is also a small chance that American policy towards Saudi Arabia may change. While it has long been America's closest ally in the Middle East, the relationship has recently come under strain. No fewer than 15 of the 19 suicide hijackers responsible for the attacks on New York and Washington last September were Saudi citizens, as is Osama bin Laden, the assumed mastermind of the atrocity.

Worried about unrest on the street—many Saudis seem to prefer the elusive Mr bin Laden to the corrupt ruling dynasty—the Saudi government gave no support to America's campaign in Afghanistan, and it has refused to allow America to use its bases in Saudi Arabia for attacks on Iraq. On the contrary, the government has instead been talking of revitalising trade with Iraq, and of reopening a border crossing closed since the Gulf war.

In turn, one researcher from the Rand Corporation, a think-tank, recently told a Pentagon briefing that Saudi Arabia was America's true enemy and that its oil fields should be seized. While the administration officially moved to distance itself from this briefing, Donald Rumsfeld, America's defence secretary, seemed to confirm that at least some officials shared the dismay at Saudi policy by saying that the views expressed were not dominant” in the administration.

Quite apart from its diminishing value as a military ally, Saudi Arabia has worked to maintain discipline in the OPEC oil-producers' cartel, and to keep prices up, at around $25 a barrel, well above what many economists think would be their market level in the absence of OPEC. This clashes directly with the interests of America, the world's biggest oil importer. Prince Turki al-Faisal, until a year ago the Saudi head of external intelligence and brother of the foreign minister, said this summer that Saudi would never use oil as a weapon against America. But Saudi's oil minister, Ali al-Naimi, spent last autumn on a tour of oil-producing capitals, trying (unavailingly) to bully producers into production cuts. OPEC recently admitted that its members had exceeded their production quotas by 1.8m bpd in July. On September 1st, Rilwanu Lukman, OPEC's president, said the cartel should be careful not to tip the oil market into oversupply by raising production too mucho.

The current overproduction suggests that, whatever the short-term war-influenced gyrations may be, the trend of the oil price may be downwards over the medium term. After the late-1990s boom, economic growth around the world has slowed dramatically, with a corresponding impact on the demand for oil.

The supply of oil is no longer controlled as tightly as it was during the 1970s oil shock. Russia has emerged as an important producer—it is now the world's second-largest exporter, and its need for cash is such that it routinely undermines OPEC's attempts to limit global production. This in turn reduces the incentive for other non-OPEC producers, such as Norway and Mexico, to agree to production cuts. Besides losing revenue, they might also lose market share to the Russians.

Even Saudi Arabia itself must be tempted to produce more oil, to pay for its extravagant public sector. While its oil is the cheapest in the world to produce—it costs just $1 per barrel to lift it from the ground—it is estimated that the country's bloated bureaucracy requires a price of $15 a barrel to sustain itself. It is a sign of how much the world has changed that America may now be looking not to its old ally, Saudi Arabia, to keep the oil flowing through a war, but to the old Cold War enemy, Russia.

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